SPACs And PIPEs: A User's Guide

Friday, February 1, 2008 - 01:00

Editor: Mr. Auguste, would you tell our readers something about your professional experience?

Auguste: For starters, you should know that I am an immigrant. I was born in Trinidad and came to the U.S. with my family in 1970. I received a scholarship to attend Phillips Academy, Andover, and I then attended Harvard College and went on to Harvard Law School. I began my career following law school at Debevoise & Plimpton. Five years later I joined Parker Chapin, which then merged with Jenkens & Gilchrist. At the time of the merger I had discussions with other firms but decided to see how things would develop with the merger. In early 2005 I joined Kramer Levin. I selected Kramer Levin over other firms because I believed that Kramer Levin would provide me the best opportunity to grow my practice, and I have not been disappointed. Of course, it does not hurt that the firm is both profitable and very well managed.

Editor: Would you tell us how your practice has evolved over the years?

Auguste: I started as a finance lawyer, and I worked on financings for institutional lender clients, including a number of major insurance companies. In time I moved over to aircraft leasing transactions. I have focused on financings and bank lending transactions, which is a natural lead-in to what I do now - helping companies raise money. The clients at the time were smaller and raised money by selling their own equity in PIPE transactions. One of my tasks was to shepherd registration statements through the SEC, which proved very valuable because I became knowledgeable about the SEC's concerns about the structure of these PIPE transactions. I also came to know, on a first-name basis, a number of SEC staff members, which has proven to be invaluable to my clients and to me. I began advising clients on structuring their deals in such a way as to avoid problems in navigating the SEC review process. My practice really changed when I shifted from the representation of issuers to the representation of investors and hedge funds.

A couple of years ago one of my hedge fund clients asked me about special purpose acquisition companies - SPACs. They had an interest in investing in these transactions and wanted me to analyze them from a legal perspective. Needless to say, I quickly got myself up to speed in this area, and before too long I was representing both issuers and underwriters in SPAC transactions. Today the bulk of my practice involves SPACs and PIPE transactions.

Editor: Speaking of SPACs, what is the origin of this investment vehicle?

Auguste: A SPAC is the evolutionary successor of the "blank check company." Blank check companies have existed for many years as an entity formed to acquire a business in the future. Blank check companies are governed by Rule 419 of the Securities Act of 1933 and, as a result, trading in the company's securities is restricted. Unlike the Rule 419 companies, the SPAC vehicle emerged as a way to trade in securities issued in an initial public offering. That meant that investors now had an opportunity to trade in and out of warrants and gain a return. The SPAC vehicle created much more trading ability, volume and larger offerings than Rule 419 companies.

Editor: Would you take us through the steps on how an IPO for a SPAC works?

Auguste: It is very similar to an IPO of an operating company. However, unlike an IPO for an operating company where you have to undertake due diligence analysis of the company, its organizational history, its place in the market, its competition, and so on, the SPAC is a newly-organized entity with no business or operating history. Typically a management team is formed to organize the SPAC and determine the specific industry in which to pursue an acquisition. The team typically has M&A experience or some background in running a public company. It is critical to select an underwriter knowledgeable about the SPAC market, one that knows the terms that investors expect and can advise on the appropriate size of the SPAC. Once the focus of the SPAC has been decided, a board of directors to bolster management is identified and the lawyers begin to prepare a registration statement on Form S-1. It takes two to three weeks to prepare the registration statement. The SEC typically comments on the registration statement within 30 days of filing. The SEC's comments form the basis of subsequent submissions, and once the SEC is ready to declare the registration statement effective, the road show follows. Typically, the SPAC IPO closes in 2 to 3 months after the initial organizational meeting.Editor: Once the SPAC has been formed, what is the role of its shareholders?

Auguste: The shareholders have a critical role because they will approve or reject the business combination selected by the SPAC. The funds invested in a SPAC is held in trust solely to fund the acquisition. If an acquisition is not consummated within a specific period of time, usually two years from the IPO, approximately 98% of the investors' initial investment is returned to investors. The release of funds can only take place upon liquidation of the SPAC or when the shareholders have voted to approve the business combination. Typically, the SPAC files a proxy statement - complying with all of the standard SEC proxy rules - describing the target. The shareholders then vote.

Editor: Please tell us about recent trends in the SPAC arena.

Auguste: It has been an interesting ride. The structure keeps changing to address SEC comments, investor demands and management's response. Initially, in connection with the shareholders vote to approve an acquisition, if shareholders elected to convert 20% of the outstanding shares into cash, the business combination could not proceed. Management believed that the 20% threshold made it difficult to consummate a transaction. Today most SPACs have a 30% threshold, and there are cases of 35% and even 40% thresholds.

Another trend concerns the " bulldog provision," which again constitutes a reaction of management to investors and/or shareholders forming a group to prevent a deal from taking place by converting their shares into cash, i.e. holding the company hostage in anticipation of receiving a premium for their shares in exchange for a "yes" vote on a potential acquisition. The bulldog provision restricts a public shareholder from acting with its affiliates and others to form a group seeking conversion in excess of 10% of their shares.

The last thing to emerge is the ability of the company to extend, by 6 or 12 months, the 24-month period to consummate a transaction, provided the SPAC has a signed letter of intent or acquisition agreement prior to the end of the 24-month period. Given the time to complete the proxy process and regulatory issues with acquiring certain businesses, such as companies located in China or India, an extension gives the SPAC more time to complete the business combination.

Editor: You have also been engaged in the private investment in public equity - PIPEs - arena. Would you give us an overview of this type of transaction?

Auguste: Basically, a PIPE transaction is a private investment in a public security. Companies that need to raise money quickly and do not want to pay the expenses for an underwritten secondary offering, often turn to PIPE transactions. Smaller or mid-cap enterprises have found PIPEs very useful. Large companies such as CitiBank have also turned to PIPEs to raise money quickly. The principal advantage for the company is that it can raise money quickly and privately. The advantage for investors is that they get a discount on the shares, and they also receive warrants as part of the deal. If the resale registration statement is declared effective quickly, investors may exit the investment if they so decide. There are disadvantages to a PIPE transaction, such as dilution of a company's stock, an immediate adverse impact on the stock price, and lack of immediate liquidity for an investor's shares.

The SEC is not favorably inclined toward PIPEs, particularly in the small and mid-market range, because of what it perceives as a potential for abuse. The SEC's response has been to expand the use of Form S-3 to smaller companies and to amend Rule 144, in an effort to make the fundraising process both more seamless and easier to use. Form S-3 was amended to permit a company with a public float of less than $75 million to sell its shares directly to the public. The company may sell up to one-third of its public float during a period of 12 calendar months. The SEC hopes that, in lieu of using a PIPE transaction, the company will put some of its shares on the shelf and sell only what is necessary to raise the money actually needed. This will limit the dilution and the size of the discount so often associated with a PIPE transaction. Unfortunately, the amendments to Form S-3 did not permit OTC companies to avail themselves of these provisions. As a consequence they must utilize PIPE transactions and go through the long-form filing process with Form S-1. Rule 144 has been amended to permit an investor to sell securities 6 months after purchase rather than 1 year. As a result, an investor may not require a company to register the PIPE shares and would rely on the 6 month holding period. This would remove the cost associated with filing a registration statement. I have been on both sides of these transactions, and I would say all these changes are positive. The market has improved dramatically, and a PIPE transaction remains a very efficient way to raise money.

I would say of both SPACs and PIPEs that a great many very creative people have been actively engaged in responding to market needs. That has made my role in this process extremely interesting. When the SPAC vehicle was introduced a few years ago, I was not sure how long it would survive. It is, I am glad to say, much more than a momentary fad. SPAC offerings have grown larger, more bulge bracket investment banks are acting as underwriters and management teams have very high profile individuals. I believe SPACs have had a very positive impact on the capital markets and together with PIPEs provide much needed capital for acquisitions and funding the growth of many companies.

Please email the interviewee at cauguste@kramerlevin.com with questions about this interview.